Earlier we looked at the format of an account to be used in the double entry bookkeeping system for recording the financial transactions of a business. What we must now do is assess the types of accounts which can exist within the records and how to treat them.
In the financial records of any business there are 6 main types of account. The number of accounts which you can have is limitless, but they will all fall into one of six categories. By being able to identify which category it belongs to helps us to decide how to use it.
The 6 categories which we use are:
- Purchases – Goods which we buy for resale
- Expenses – Costs we incur in carrying out our business
- Assets – Items we own and use to help us generate profits
- Revenue – Income generated from trading
- Liabilities – Amounts owed to third parties
- Shares/Capital – Investment, profits and drawings of owners
All accounts can be aligned into one of the above headings.
So far we have looked at 2 types of transactions. David bought a van, as we saw the two accounts which have been used were bank and van. Both of these accounts are assets.
The Profit of a company is calculated by subtracting purchases and expenses from the revenue
Revenue – Purchases – Expenses = Profit
If we think back to our accounting equation all 6 of these headings are in the full equation
Assets – Liabilities = Shares/Capital + Profit (Revenue-Purchases-Expenses).
Before we can begin to records transactions we must be able to identify which of the six headings our two accounts fall into. As we move through to beginning our double entry bookkeeping system this is a crucial step which we must be able to command.
Some examples of each heading could be:
- Purchases – Raw materials, Packaging and Delivery costs of materials.
- Expenses – Rent, Insurance, Telephone and Stationery.
- Assets – Bank Accounts, Equipment, Motor Vehicles and Trade Debtors (customers who owe us money).
- Revenue – Sales.
- Liabilities – Bank Loans, Unpaid Taxes, Trade Creditors (suppliers who we owe money to).
- Share/Capital – Invested Capital.
Being able to successfully identify which one of the 6 headings an account falls into will help us be able to correctly record that transaction in the businesses records.